RBI Implements Stringent Guidelines to Address Evergreening in AIF Investments by Regulated Entities

Key Takeaways:

1. RBI issued guidelines to address evergreening in AIF investments by regulated entities.

2. Regulated entities are prohibited from investing in AIF schemes with downstream investments in debtor companies of the regulated entity.

3. Lenders must liquidate their investments in such AIF schemes within 30 days or make a full provision for the value of the investments.

4. Opinions on the guidelines are polarized, with some experts appreciating the initiative for enhancing transparency and others criticizing the comprehensive nature of the directives.

5. The guidelines may have substantial repercussions, impacting Assets under Management (AUM) and posing challenges for lenders, NBFCs, and AIFs.

Synopsis:

The Reserve Bank of India (RBI) issued guidelines on 19th December 2023, addressing investments made in Alternative Investment Funds (AIFs) by Banks and Non-banking Financial Companies (NBFCs), with the aim of tackling the issue of “evergreening”. Evergreening involves concealing the true extent of bad loans by allowing delinquent borrowers to take additional loans to repay existing ones. AIFs are privately managed funds with a minimum investment amount of INR 1 crore, attracting investors such as family offices, High Net worth Individuals (HNWIs), banks, and NBFCs. These funds typically allocate investments across various asset classes, including venture capital, infrastructure funds, and high-yielding debt instruments, making them one of the fastest-growing investment vehicles in the country, alongside Mutual Funds (MFs).

The RBI expressed concerns about certain banks and NBFCs potentially using AIFs to conceal their non-performing or bad loans. There is a suspicion that investors in these AIFs may be leveraging their investments to transfer their bad loans to these funds, effectively removing such loans from their books. To address these practices, the RBI implemented stringent measures, prohibiting regulated entities from investing in AIF schemes that hold downstream investments in debtor companies of the regulated entity. Additionally, lenders who have invested in such AIF schemes falling within the scope of the guidelines are required to liquidate their investments within a 30-day timeframe, failing which they must make a full provision for the value of the investments.

Opinions among experts on the matter are polarized, with some appreciating the initiative for enhancing transparency in the disclosure of bad loans, while others criticize the comprehensive nature of the directives. The guidelines have raised concerns, particularly among lenders who had invested in AIFs for asset diversification and higher returns, as the requirement to liquidate AIF investments within a 30-day timeframe poses a significant challenge, compounded by the absence of a secondary market in India for these unlisted AIF units. The potential repercussions of the RBI guidelines are substantial, with an estimated impact on Assets under Management (AUM) ranging from INR 20,000 to INR 30,000 crores.

The guidelines are expected to discourage lenders from investing in AIFs, even when driven by genuine motives. Various industry bodies have communicated their concerns to the RBI, proposing an alternative approach that would ensure genuine investments in AIFs continue while discouraging evergreening. They suggest enforcing the directives only when the lender’s investment in the AIF constitutes at least 25% of the AIF’s total investment in the debtor company, and the lender’s loan to the said debtor company is due within a year of the lender’s investment in the AIF.

The potential impact of the guidelines on the financial sector, AIFs, and lenders, as well as the polarized expert opinions, reflect the complexity and significance of the RBI’s measures in addressing the issue of evergreening in AIF investments by regulated entities.

FAQ:

Q1: What are the RBI guidelines aimed at addressing?

A1: The RBI guidelines are aimed at addressing the practice of “evergreening” in Alternative Investment Funds (AIFs) by Banks and Non-banking Financial Companies (NBFCs).

Q2: What are the key restrictions imposed by the guidelines?

A2: Regulated entities are prohibited from investing in AIF schemes that hold downstream investments in debtor companies of the regulated entity. Additionally, lenders who have invested in such AIF schemes are required to liquidate their investments within a 30-day timeframe or make a full provision for the value of the investments.

Q3: What are the potential repercussions of the RBI guidelines?

A3: The guidelines may have substantial repercussions, impacting Assets under Management (AUM) and posing challenges for lenders, NBFCs, and AIFs. The necessity for lenders to consider a fire sale to offload assets or provision for them poses a considerable challenge.